Question

Calculate the cost of debt from the following information: company cost of capital = 15%, cost of equity capital = 16 per cent, D = $0.2 million, and V = $0.5 million.

A. 12.5%
B. 13.5%
C. 10.5%
D. 15.5%

Answer 1

Solution:
	Answer is B. 13.5%
Working Notes:
	cost of capital is WACC =15%
	Cost of equity Ke = 16%
	Cost of debt Kd = ???
	Value of Debt D = $0.2 million
	Value of Company V = $0.5 million
	Value of Equity E = V -D = $0.5 million - $ 0.2 million
	Value of Equity E = V -D = $0.3 million
	WACC = (E/V)Ke + (D/V) Kd
	15% = (0.3/0.5) x 16% + (0.2/0.5) x Kd
	Kd= (15%- 9.6%) x 0.5/0.2
	Kd= 5.4% x 0.5/0.2
	Kd= 13.5%
	cost of debt Kd = 13.5%
Notes:	WACC is the weighted average cost of capital which is also called cost of capital.
Please feel free to ask if anything about above solution in comment section of the question.